The View from our Whitehouse

Sunday, November 18, 2018

Things have been pretty calm in terms of overall market activity despite some occasional bouts of volatility. Despite hundreds of forecasts across the spectrum of economic views that we are about to see a huge new major crisis, that has yet to emerge. The 2018 elections are over now and will results in predictable gridlock which markets don't normally find too bothersome.

Lately though, a few indications that we might be about to see some kind of rollover in the economy have begun to show up. The stock market is now struggling and more and more view as overpriced. The housing market is showing some signs of a slow down with mortgage rates creeping higher. Same with auto sales. So we continue to monitor things to see if these are just minor pullbacks or the start of something more significant.
------------------------------------------------------------------------------------------------------------------Unfortunately, it is impossible to try and analyze the potential for future economic conditions without taking into account the political ramifications. So what follows below is an attempt to try and project what we might see in 2019/2020 given the current political landscape.From 2016-2018, the Republican Party controlled The White House, the Senate, and the House of Representatives. While its true that the slim majority held in the Senate did place some limits on what Republicans could get passed into legislation, for political perception purposes, the public would view whatever happened economically during 2016-2018 as being owned by Republicans. I think this view is not entirely proper because there are many longer term factors that impact the economy (good and bad) unrelated to whatever the political party in power does. But in general, the public probably does not view things that way which is what matters in terms of political fallout.For the most part, the general perception is that the economy did well during 2016-2018 which probably allowed the Republican Party to limit its losses in Congress in the recent mid term election. It is also probably true that if we had seen the new major financial crisis many are still expecting to arrive during 2016-2018, President Trump would have taken most of the blame for it just as he claimed most of the credit for what most viewed as a good economy. With total control of The White House and Congress, it would have been pretty hard to shift blame elsewhere in the public perception.So what happens now in 2019-2020?Now the political perception situation has been altered. The Democrats will now control the House of Representatives. We can be pretty sure they will use this new found power both to impose gridlock on any new legislation President Trump would want and to harass him with various investigations for the next two years. Without control of the Senate, this will mostly be just noise, but will certainly insure that no further major agenda items for President Trump will go anywhere (the possible exception being some kind of infrastructure bill).How will this impact markets and the economy?It is too early to say right now. We will consider two alternatives in this analysis:1)Gridlock along with continuing rising interest rates slows down the economy and cause some correction in the stock market, but not a severe decline.We will call this the minor impact alternative. If this is what happens, we can expect that not all that much is going to change in the next two years and that nothing terrible will happen requiring someone to be "blamed for causing the problem". In politics, perception is pretty much everything. With a divided government where nothing major happens good or bad, it is pretty hard for either side to successfully blame the other side. Further stalemate seems the most likely outcome.2)The economy rolls on over from here into a severe decline and the stock market takes a severe drop. The possible signs of a topping out and rollover we see now pick up momentum and turn into the major crisis so many have expected now for years. The entire financial system comes under risk once again (worse than the 2008 crisis).Here is where it gets interesting. If we really do get into a major economic decline of the kind people like Jim Rickards have been predicting for a long time, someone is going to have to be blamed in an effort to push the political fallout their way.We don't even have to guess what President Trump will do under this scenario. He has made it clear. He has already tagged the Fed for blamedue to tighter money policies. And he has already made it crystal clear he will blame Democrats for a falling stock market.So the President already has two convenient scapegoats lined up in case things really do go south significantly the next two years.We can expect that Democrats along with all others opposed to President Trump will do everything they can to lay the blame on President Trump. Perhaps they will argue that the last two years were just a carry over effect from years of low interest rates and easy money policies that President Trump rode to its crest. Whatever they feel will resonate best with voters is probably what they will go with. But we can be pretty sure they will blame President Trump.In the second scenario, the Blame Game likely ramps way up in 2019-2020. An already divided nation will probably see even more intensity on both sides as the political stakes for who the public blames for the crisis would be enormous. That may be hard to imagine given what we have already seen, but in any crisis things become even more intense. Also, under severe crisis conditions, the door tends to open wider for what are normally considered more extreme views to gain momentum. This could range from the socialist agenda coming from the left to the "end the Fed" agenda on the right. If a majority of the public views the present system as failing, they tend to be more interested in listening ideas for radical change.It is this second scenario we should watch for and monitor carefully the next two years. If we get the first scenario. nothing major is likely to change in terms of our financial system or monetary system. But under the second scenario, the potential for some kind of major change increases and what that change looked like probably would depend on who the majority of the public blamed for the crisis (an unknown in a complex system).I offer no predictions here. I just attempt to monitor events and offer the best analysis I can based on what actually happens. If I had to guess right now, I would guess scenario #1 above is more likely than scenario #2. But who really knows? The conventional wisdom has been wrong as often as it has been right in recent years.Added note: Unless some significant news event arises to cover, this may be the last article on the blog for the next month or so.

Wednesday, November 14, 2018

The short answer is no. At least not any time soon. The IMF releases this new study on the prospects for central bank digital currencies (CBDC's) and Managing Director Christine Lagarde offered her thoughts on the subject in this recent speech. Below are a few excerpts from each and then a few added comments.

First, frame the issue in terms of the changing nature of money and the fintech revolution.

Second, evaluate the role for central banks in this new financial landscape—especially in providing digital currency.

Third, look at some downsides, and consider how they can be minimized.

. . . . . .

Conclusion

Let me conclude. I have tried to evaluate the case this morning for digital currency.

The case is based on new and evolving requirements for money, as well as essential public policy objectives. My message is that while the case for digital currency is not universal, we should investigate it further, seriously, carefully, and creatively.

More fundamentally, the case is about change—being open to change, embracing change, shaping change.

Technology will change, and so must we. Lest we remain the last leaf on a dead branch, the others having decided to fly with the wind.

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From the newly released IMF study on Central Bank Digital Currencies:

VII. CONCLUSION

- CBDC could be the next milestone in the evolution of money. The history of money
suggests that, while the basic functions of money might not change, the form does evolve in
response to user needs. Digitalization of many aspects of economic activity is prompting central
banks to seriously consider the introduction of CBDC.

- CBDC is a digital form of existing fiat money, issued by the central bank and intended
as legal tender. It would potentially be available for all types of payments and could be
implemented with a variety of technologies.

- Overall, the note finds no universal case for CBDC adoption as yet. From the
perspective of end user needs, it finds that demand for CBDC will depend on the
attractiveness of alternative forms of money. In advanced economies, there may be scope for the
adoption of CBDC as a potential replacement for cash for small-value, pseudo-anonymous transactions. But in countries with limited banking sector penetration and inefficient settlement
technology, demand for CBDC may well be greater.

- From a central bank perspective, the case for CBDC is likely to differ from country to
country. CBDC may reduce the costs to society that are associated with the use of cash. Moreover,
CBDC may improve financial inclusion in cases of unsuccessful private sector solutions and policy
efforts. It could also help central banks bolster the security of, and trust in, the payment system and
protect consumers where regulation does not adequately contain private monopolies. But
regulation and, where possible, novel payment solutions could offer compelling alternatives to a
CBDC.

- For countries that decide to introduce CBDC, appropriate design and policies should
help mitigate ensuing risks. Monetary policy transmission is unlikely to be significantly affected
and may even benefit from greater financial inclusion. Moreover, though it will not eliminate illicit
activity, CBDC may in some situations enhance financial integrity. However, it also entails risks for
financial integrity if badly designed. In addition, although CBDC could increase the cost of funding
for deposit-taking institutions and intensify run risk in some jurisdictions, design choices and
policies can help ease such concerns. Nevertheless, operational and reputational risks arising from
malfunctions of the digital infrastructure or cyberattacks are likely to remain as challenges.

- Looking ahead, the cross-border implications of CBDC raise a multitude of new
questions that merit investigation. For instance, from a practical standpoint, how would tourists
be able to make payments in a foreign country that has adopted CBDC? Should foreigners have
access to CBDC? To what extent would this complicate know-your-customer and AML/CFT
compliance, and could standardized information be requested across countries? Would access to
CBDC in a reserve currency (such as e-dollars) facilitate currency substitution in countries that have
weak institutions? And to what extent might safe-haven flows be encouraged, potentially draining
resources from countries that face banking, sovereign, or currency crises? Finally, if CBDC were used
for cross-border transactions, how might central banks be required to cooperate? Would they
absorb some of the functions of correspondent banks and thus take on additional liquidity, credit,
and foreign exchange rate risk—or might tokens be created for cross-border payments among
particular central banks, commercial banks, or firms? Research on CBDC should proceed resolutely
given that the questions to be explored are deep and difficult and have far-reaching implications.

My added comments: At first glance, if you have not followed this topic for any length of time, it may appear that we have a bold new initiative from the IMF endorsing the use of central bank digital currencies within nations at first and later perhaps a new digital global reserve currency. Director Lagarde sounds somewhat like an enthusiastic supporter of the concept in her speech.

Digging into the conclusion section of the actual IMF study, I listed most of the key conclusions above and added bold type and underlines to some points I wanted to emphasize. Looking at these key points, it is clear that the IMF is not proposing a new global central bank currency like we have talked about here for some time any time soon. Rather this study focused on individual national central banks potentially issuing a digital version of their own national currencies and listed some pros and cons. This has been done over and over again around the world by individual central banks such as the BOE as well.

The concept clearly gets a lot of attention and study, but nothing in these studies ever suggests that any major central bank is close to moving forward with actually implementing the idea. And it seems pretty clear from this new study that the IMF sees that as having to take place first before any kind of new global digital currency (like an e-SDR for example) might be considered. The study does go on to relist a number of problems and challenges to the idea that still have to be overcome as well.

None of this suggests to me that we are on the verge of anything like this happening soon. Clearly, the idea exists and has not been abandoned. But nothing in this new report suggests any further progress toward actual implementation has been made.

The final words of the conclusion are: "Research on CBDC should proceed resolutely given that the questions to be explored are deep and difficult and have far-reaching implications."Does that sound like a new digital global reserve currency is just around the corner?

So I view this new study as just more of the same with no new information of substance provided from what we have already covered here in depth. But you can read through the entire IMF study to see if you agree or disagree with my conclusion on that.

-----------------------------------------------------------------------------------------------------------------Added note:This CNBC article adds a bit of extra information including the fact that Sweden may test a CBDC sometime in 2019.

Monday, November 12, 2018

Following up on John Bolton's recent comments that US debt may pose a "threat to society", Jim Rickards explains that the US is continuing to go broke, slowly but surely. Below is an excerpt from his article on this.
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"As Grant points out, the national debt has registered compound annual growth of 8.8%, but only 6.3% for GDP. That’s not a sustainable situation. And it’s not at all clear that GDP will close the gap.Basically, the United States is going broke."---------------------------------------------------------------------------------------------Additional comments: Not to worry though. No one really cares about this and it's pretty clear no one thinks it will ever matter in any meaningful way. The only time anyone expresses "deep concern" over this situation is when their political party is out of power. Now both parties have some power so no one has to bother with pretending to be concerned (unless polling indicates there is some political gain to be had). And we can be sure that any concerns that are expressed will blame the "other guys" for the problem if anything bad does actually happen. Markets should be pretty happy as all this is completely predictable and markets love that.

Friday, November 9, 2018

We have heard this said many times, but White House National Security Adviser John Bolton is the latest official to point to the US debt as a systemic threat. His comments were widely reported and you can read them in this article (a couple of excerpts below).

“It is a fact that when your national debt gets to the level that ours is, that it constitutes an existential threat to the society,” Bolton said. “And that kind of threat ultimately has a national security consequence for it.”While Congress will have the final say, Bolton also affirmed the White House Office of Management and Budget is planning 5 percent cuts across all government agencies for its fiscal 2020 budget proposal expected in February. That plan, which Trump disclosed at a Cabinet meeting on Oct. 17, has prompted “howls of outrage … from various parts of the government,” Bolton said."

My added comments: This is nothing new and we have reported comments similar to this for years. here. Readers who want to look at an in depth article that does a good job of summarizing the overall situation may want to read this article by James Grant. Below are a couple of excepts from that article which points out that despite massive US debt and deficits, markets so far have not reflected any concerns. The conditions for problems are always out there, but until the stock and bond markets reflect concern, no one is motivated to do anything to change the status quo.

"America’s deteriorating public credit is the cold-button issue of the 2018 midterms. With rare bipartisanship, Democrats and Republicans compete to pretend that the country isn’t going broke. In 1992, the third-party presidential candidate Ross Perot likened the widening gap between federal receipts and federal spending to “the crazy aunt tucked away in the room upstairs nobody talks about.” The old gal’s dottier than ever."

. . . .

"The sophists and economists who contend that we ought to borrow because, at an interest rate only slightly over 2 percent, we can hardly afford not to borrow, have a point of a kind. In 1988, on a debt of $2.6 trillion, the Treasury paid net interest of $152 billion. In the just-ended fiscal year, on $21.5 trillion of debt, the Treasury paid net interest of $371 billion. Thus, over the past 30 years, the debt jumped by 727 percent, the cost of servicing it by just 144 percent. To the casual question, “What’s the harm in the Treasury’s availing itself of the market’s over-generous hospitality?” there is no casual, tweetable answer."

. . . .

"But the 21st-century Treasury is under no pressure to take such actions (to reduce the debt). Its creditors, for now, seem perfectly happy. Though the supply of government securities on offer this fiscal year, from all sources, including the Federal Reserve, is projected to be the greatest, as a percentage of national output, since World War II, interest rates have risen only by enough to rattle President Trump and (at this writing) the stock market; the government is still easily financing its $3.9 billion or so of daily new borrowing needs. The dollar-exchange rate likewise signals complacency. In the worldwide laundromat of fiat money, the dollar is the cleanest dirty shirt."

Wednesday, November 7, 2018

As expected, the mid term elections were mostly a non event other than the Democrats taking control of the House. That will certainly ramp up division even more and we can expect a lot of efforts to investigate and/or impeach President Trump.

This will all mostly be window dressing as with a solidly GOP Senate, impeachment efforts will go nowhere eventually. They might disrupt markets though and we can expect continued volatility there. We are due for a recession now so that might be likely to happen during these next two years. The Democratic take over of the House will provide Trump and Republicans with a scapegoat for that now which did not exist prior to this election. All this is pretty predictable.

I don't see anything from this election at this time that would lead to major monetary system change unless we get the new major crisis many have predicted for a long time now. So nothing has really changed much.

------------------------------------------------------------------------------------------------------------------------Unless something dramatic does happen to the overall economy and markets, it now seems pretty likely that President Trump will be re-elected to another term. I say this because we did not see a major voter revolt against President Trump in this election as some were expecting. Instead, we saw voters in some areas not happy with President Trump elect enough Democrats to the House to create a check on his ability to move forward much more with his agenda. So, we can expect mostly gridlock for the next two years. Gridlock is not likely to hurt his chances for being re-elected because he will just blame the Democrats for being obstructionists and his voters will be fine with that explanation. If Democrats spend the next two years just trying to impeach him, that will actually probably play to his advantage in 2020. In some ways, the result of this election may have actually helped him out.In addition, with the GOP winning key Senate races and governor races in Ohio, Florida, Georgia, and Iowa, he will have strong state level support in those key states in 2020. Also, the Republican side of Congress is now much more pro Trump, especially in the Senate where Senators who were critical of Trump were replaced with pro Trump Senators.On top of all this, now if the economy and markets take a nose dive in the next two years, Trump now has the perfect scapegoat available. It will all be because the Democrats took over the House, blocked his agenda, and ruined the economy. We can predict this will be his talking point under that scenario. Again, it is almost a perfect setup to run for re-election in 2020.Conclusion: As usual, after all the hand wringing and hyperbole, the election was really mostly a non event for a mid term election. The party in power always loses seats and this was a relatively minor loss from a historical standpoint. It will likely create full on grid lock once again, but we as a nation are pretty used to that anyway and many voters seem to actually prefer it.Nothing from this election seems likely to promote any major changes in our monetary system or anything else for that matter for the next couple of years. Maybe they will pass an infrastructure bill, but it seems unlikely much else will happen. In the Senate, Presidential nominees should make it through quicker and easier now, but that should have little or no impact on the economy or monetary system.

Saturday, November 3, 2018

Last month we ran this way off topic post in an effort to demonstrate that despite all the division and problems we see around us daily, there is plenty of good being done in the world if you take just a bit of time to look for it. This month I am happy to offer yet another off topic post along these lines.

My daughter made me aware of this inspiring project. It's about a man who is dedicated to raising private funding for water wells in Liberia where clean fresh water is not available to many people. To focus attention on the problem, this man made a vow to live on a homemade floating barge on a local lake in our area until he had raised his goal of about $2.3 million for water wells in Liberia. The company my daughter works for is helping to sponsor this effort and asked her to write an article on it which you can read by clicking here. Below are a couple of excerpts from the article.
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"This fall Todd Phillips, the Founder and Executive Director of the nonprofit organization The Last Well, is bringing “living water” to the country of Liberia by living on the water himself.. . . . Phillips is living on a barge floating in Lake Ray Hubbard indefinitely until The Last Well reaches its fundraising goal of $2,290,000. As of October 26, 2018, Phillips has been living on the barge for 17 days and has raised $1,381,128–60% of total goal.The concept for The Last Well Fundraiser was designed to call attention to the fact that while we have an abundance of clean drinking water in America, Liberians do not have this basic necessity.“Most of the drinking water for East Dallas comes from Lake Ray Hubbard,” Phillips said. “We wanted to do something that shows we have water, but they don’t, and that’s not ok.”

Todd Phillips of Last Well-------------------------------------------------------------------------------------------------------------------------My added comments: While politicians and others around them spend enormous amounts of time and money to try and obtain political power and influence, it is so inspiring to see people give up their own time and money just to try and help others in need. When we see this attitude become more prevalent again in our society, maybe we can start to move towards healing some of the divisions at least in a small way. Everyone needs water and I can't imagine anyone not wanting this effort to be successful.Added note: I do not know Mr. Phillips personally, but I certainly admire the sacrifice he is making to try and raise these funds. Weather in our area has been very harsh at times in recent weeks with rain and thunderstorms while this barge has been floating out on the lake. He provides a nightly Facebook live update for followers here.

Tuesday, October 30, 2018

This is just a brief news note to say that it does not appear that anything related to the US mid term elections is likely to impact major monetary system change. Below I have listed the potential outcomes and how they might impact things.
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- Democrats take over both the US House and US SenateThis has been touted as a strong possiblity for some time, but more recent polling suggests this is now unlikely. However, this is the scenario that could have the most potential impact. We can assume that if the Democrats take control of the House, they will at a minimum prevent any further major legislation from being passed. At maximum, they will launch an effort to impeach President Trump. All that could certainly create a lot of market volatility and disruption. It is extremely unlikely that this would lead to President Trump being removed from office because that takes a 2/3 vote of the US Senate. The Democrats will not have anything close to that in the Senate regardless of how this election turns out. Also, removing President Trump simply puts in Vice President Pence and likely little to no change in policy from the Executive branch of the government.- Democrats take over the House, but not the SenateThis is the more likely scenario as of this writing although more recent polling shows that control of the House is probably very tight and could go either way. For our purposes, nothing changes from the above analysis other than it becomes even less likely that President Trump would be removed from office and the Democrats might not even attempt impeachment since they would not have control of the Senate.- Republicans hold the House and SenateThis scenario leaves things pretty much unchanged from the current situation. It is very unlikely anything major would change policy wise in this scenario. Also, there would be no effort towards impeachment in the House. Markets would probably not be impacted in any way in this scenario. Summary: I do not see anything related to the election that is likely to impact major monetary system change. I do see a lot articles in both mainstream and alternative media suggesting that markets may be about to roll over into a major correction and there are always lots of people predicting another major crisis at any given point in time. So nothing new there. The continued strength of the US dollar could create some problems and is probably the result of interest rates going higher along with the QT policy of the Fed.The conditions for this are always present, but so far have not led to any kind of new major crisis. Should a new crisis emerge, President Trump has already made it clear he will blame the Federal Reserve for it and that would probably create some market disruption. An already badly divided nation would probably become even more intensely divided. Trump allies/supporters will go along with blaming the Fed. Trump opponents will blame it on Trump. That much is pretty predictable.Added note: Here is Jim Rickards take on the upcoming election (and the potential for market impact) for anyone interested.

Wednesday, October 24, 2018

A thank you to a reader for pointing me to this article by Barry Eichengreen on the Project Syndicate web site. The article is another in a long line that ponders whether or not nations can find sustainable ways to get around using the US dollar. This is a hot topic these days and a lot of people are watching to see how things play out. Below are a couple of excerpts from the article and then a few added comments.

Having unilaterally reimposed sanctions on Iran, US President Donald Trump's administration is threatening to penalize companies doing business with the Islamic Republic by denying them access to US banks. But that could hasten the dollar's demise as the main global currency.

. . . . .

"If the geopolitical shock of Trump’s unilateralism spurs an institutional innovation that makes it easier for European banks and companies to make payments in euros, then the transformation could be swift (as it were). If Iran receives euros rather than dollars for its oil exports, it will use those euros to pay for merchandise imports. With companies elsewhere earning euros rather than dollars, there will be less reason for central banks to hold dollars in order to intervene in the foreign exchange market and stabilize the local currency against the greenback. At this point, there would be no going back.

One motivation for establishing the euro was to free Europe from excessive dependence on the dollar. This is likewise one of China’s motivations for seeking to internationalize the renminbi. So far, the success of both efforts has been mixed, at best. In threatening to punish Europe and China, Trump is, ironically, helping them to achieve their goals."

My added comments: Thus far, while there have been endless articles about how one thing or another will lead to the demise of the US dollar as global reserve currency, that has not happened. Until it does happen, there is no reason to suggest we are on the cusp of major monetary system reform.

In this new article, Mr. Mueller says that the US dollar acting as the world's global reserve currency is actually a problem rather than an advantage for the United States. Below are a couple of excerpts from his article and then a bullet point summary of some of the key points.

"Donald Trump promised to "make America great again," but he might make America Great Britain. To re-industrialize the U.S. economy, President Trump must avoid the mistake that de-industrialized Britain: Namely, he must end the dollar's role as the world's chief reserve currency.". . . . . "French economist Jacques Rueff described the fatal weakness of foreign-exchange reserves in a 1932 lecture. He explained that when a monetary authority accepts dollar or sterling claims for its official reserves rather than gold, purchasing power "has simply been duplicated," so that, for example, "the American market is in a position to buy in Europe, and in the United States, at the same time." In other words, when a foreign nation accepts repayment in U.S. dollars it increases its money supply without diminishing the U.S. money supply, allowing both countries' central banks to lend in dollars.This credit "duplication" is not only inflationary in the reserve-currency country and any country whose currency is tied to the reserve currency; it also necessarily causes the average price of goods to rise faster in the reserve-currency country than among its trading partners. This is why Britain's and America's manufacturing industries lost their competitiveness as exporters, resulting in deindustrialization.". . . . . "The Triffin Dilemma can't be solved without a monetary reform that ends the dollar's use as the world's chief reserve currency.Here's a deal that could place Mr. Trump in Alexander Hamilton's league:"

-President Trump should work towards removing the US dollar as global reserve currency

- Using a national currency as global reserve currency leads to the "Triffen Dilemma"

- This very problem contributed to the "deindustrialization" of Great Britian

- the glut of reserve currency leads to inflation and lack of global competitiveness- Tariffs cannot restore competitiveness- The Triffin Dilemma cannot be solved without monetary reform ending the US dollar as the global reserve currency- President Trump should offer a plan to convert all foreign US dollar reserves to long term government to government debt- This debt should be paid off in gold over a period of 50 years, similar to a plan used by Alexander Hamilton to pay off American revolutionary war debtThe article concludes as follows:"Like Mr. Trump, Hamilton's contemporaries originally thought his glaring character flaws far outweighed his virtues. But after the formerly penniless immigrant managed to make a fortune for his adopted country, even those who had been his worst political enemies found it in their interest to carry out his plan for decades. Today, young people whistle the songs not from "Jefferson" but "Hamilton." There will be no whistling of tunes from "Trump" if he makes America Great Britain."

Monday, October 15, 2018

We have documented numerous warnings here over the last 4 and 1/2 years from both the IMF and the BIS related to potential systemic risks. None of those warnings has turned into another major financial crisis thus far.

Christine Lagarde (IMF) just issued a new warning on the global economy due to ongoing trade disputes, rising interest rates, and an increasing global debt burden. Below are a couple of excerpts from this article in MarketWatch.

My added comments: It is easy to sound like a broken record just repeating systemic risk warnings over and over and yet nothing ever actually happens. That's OK. The risks do exist so it is important to report them even if nothing comes of it. By now, it should be obvious that no one can predict the timing of future events, but it is possible for most everyone to make some kind of plan to deal with a crisis if one did arise.Added note: This article appearing in ABC.net.au includes this interesting comment from the IMF regarding the next major crisis:"The IMF also said action by central banks, notably the US Federal Reserve and the European Central Bank, to bail out institutions and stimulate economies through trillions of dollars of quantitative easing would not be possible in managing any new crisis."I noted these comments because they agree with what Jim Rickards has said for some time and we have reported his view on this here for some time as well.

Monday, October 1, 2018

This post will be somewhat different and certainly way off the main topic of this blog. In trying to cover the topic of potential monetary system reform, you run across a lot of potentially discouraging news and information. It seems that many believe that any major change we might see to our present monetary system will come from the arrival of some new horrific future major financial crisis. There is nothing fun about trying to learn about the potential for such an event and then trying to provide information to help others learn what to watch for and then what solutions might be available to deal with such a crisis if one does arrive some day.

On top of that, in order to try and stay informed on the relevant issues, you are pretty much forced to follow all the political news that now pours out on a 24/7 basis across all kinds of media formats. The US is more intensely divided now than at any time I can recall in my lifetime. Seeing the non stop fighting that has only ramped up since the election of Donald Trump is truly discouraging. It seems there is no end in sight for all that.

So, for this post, I would like to put all that aside just for a few minutes. If all we ever do is focus on all that, we might miss the fact that despite all the problems and divisiveness we see around us, there is still plenty of good if we just take time to look for it. Below I am going to post two videos that (at least to me) offer hope that despite our differences, people can come together and be touched to see that we do have some things in common even while we may disagree on some issues. I hope you enjoy this little break from all the noise.
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It is once again time for the State Fair of Texas held annually in Dallas. This time of year is always very nostalgic for me as I recall the many years taking my daughter to the Fair and what wonderful memories we have of those times together. When she was very young, one of her favorite shows to see at the State Fair was a dog named Skidboot (he has now passed away). Skidboot brought so much joy to so many people that he ended up having a career far beyond the State Fair of Texas appearing on such TV shows as Oprah and The Tonight Show. Near the end of his life, a local TV program called Texas Country Reporter did the feature just below on Skidboot and his owner David Hartwig of Quinlan, Texas. I doubt many can watch this video and not feel something good inside about people (and their best friends), so I present it here. I hope you enjoy it.

---------------------------------------------------------------------------------------------------------------------This next video arises out of terrible tragedy that happened in Dallas recently. Many may have heard about it. A young man (Botham Jean) was shot and killed by an off duty police officer in what appears to have been a horrible mistake. The officer stated that she mistook his apartment for her own after coming home from a long on duty shift. Thinking a burglar was in her own apartment, she fired twice killing Botham Jean.This event came close to home for us. Botham recently graduated from the same university that my daughter attended so she did know him, although not as a close friend. Everyone there knew him because he had a beautiful singing voice and would sometimes lead a daily chapel service held at the school. The loss of such a wonderful young life is tragic and the grief of his family and friends is very real and deep. The uplifting part of this story is how that family and those friends chose to react to such a terrible tragedy and to honor his life. His funeral service in Texas was attended by hundreds of people whose lives he had touched from around the world (here is a link to that service for anyone interested - service starts around 2 hour mark). You simply cannot watch the video linked above of his funeral service and the video just below and not be uplifted at how people can come together during very difficult times to offer hope and encouragement to one another. This is when we are at our best in my view. I think if we just take a little time now and then to Search for the Good, we can find it even in these times of great division.----------------------------------------------------------------------------------------------------------------------

This video is the candlelight vigil held by students at the university where Botham graduated He sometimes led the student body there in singing at their chapel services.

"It’s been 10 years since Lehman Brothers collapsed, setting off a global financial meltdownthat would take years to correct. A decade later, there are some guardrails in place to prevent a Great Recession 2.0 — but another crisis at some point is essentially inevitable.. . . .A decade later, there’s been a lot of reflection on what happened in the financial crisis — and whether a repeat could be on the horizon. I reached out to eight experts to ask how far we’ve come, specifically in terms of government policy, in guarding against another financial and economic calamity. Simply put, are the guardrails in place to prevent another financial crisis like what happened in 2008?"

Here are some of the comments of one of the eight experts interviewed as an example of the type of input they offer:

Bill Emmons, assistant vice president and economist at the Federal Reserve Bank of St. Louis:

"The guardrails are not in place to prevent another crisis like 2008. However, I don’t think another crisis like that is likely anytime soon. The underlying conditions in the economy and financial markets are very different today, in large part because the crisis occurred and left lots of damage in its wake. . . . . "

"If we take a further step back, the bout of volatility engulfing EMEs should not come as a surprise. As noted in the BIS Annual Economic Report, these developments are symptoms of a broader malaise. The highly unbalanced post-GFC recovery has overburdened central banks. The powerful medicine of unusually and persistently low interest rates has served to boost economic activity, but some side effects were inevitable. The financial vulnerabilities that we now see are, to some extent, one such example. The market ructions are akin to a patient's withdrawal symptoms.

What happens next is, as always, hard to tell. Will the patient continue to mend, as looked likely until the first quarter of this year, or will there be a relapse? What one can say is that the patient's full recovery will not be smooth. On the financial side, things look rather fragile. Markets in advanced economies are still overstretched and financial conditions still too easy. Above all, there is too much debt around: in relation to GDP, globally, overall (private and public) debt is now considerably higher than pre-crisis. Ironically, too much debt was at the heart of the crisis, and now we have more of it - although, fortunately, banks have reduced their leverage thanks to financial reform. With interest rates still unusually low and central banks' balance sheets still bloated as never before, there is little left in the medicine chest to nurse the patient back to health or care for him in case of a relapse. Moreover, the political and social backlash against globalisation and multilateralism adds to the fever.

Policymakers and market participants should brace themselves for a lengthy and eventful convalescence."

My added comments: The comments in this Vox article are pretty much in line with what I have heard from other experts. The thinking seems to be that the potential for another major crisis does exist, but most do not see any signs that one is on the near term horizon. The most frequently mentioned potential triggers for another crisis I see mentioned are:

- trade wars & currency wars leading to actual wars

- shadow banking where regulators are not able to assess systemic risks very easily

- derivatives within a highly interconnected banking and financial system

Saturday, September 15, 2018

In 2008 the world was rocked by what is now called the Great Financial Crisis (GFC). The crisis brought down some banking institutions, prompted emergency action by the US government, and triggered an unprecedented reaction from central banks around the world led by the US Federal Reserve. New and never before tried monetary policies were implemented and literally trillons of units of various fiat currencies were created in a global effort to keep the system from imploding due to contagion.

Now, its 2018. So far a systemic collapse has been avoided and most people have slowly released concerns about the stability of the system from their minds. Despite this, there is a nagging problem that most everyone acknowledges; and yet nothing serious is done about it. We are talking the huge debt burden that overhangs both the US and the world. The National Debt clock is still documenting the ever expanding US debt burden (now over 21 Trillion and don't even ask about unfunded liabilities).

As noted above, virtually everyone describes this growing debt as a true systemic risk. Not only for the US, but for the world as well. Just this year both the IMF and the BIS repeated warnings on debt as a systemic risk for the world in general. A chart from the World Ecnomic Forum captures the total global debt picture as of early 2018.

For years and years now, these kinds of warnings have been issued not only by the IMF and the BIS, but also policy makers, politicians, think tanks, and various organizations concerned about the issue (here is one example and here is another). In the US, politicians from both major political parties speak in dire terms about how awful the debt problem is, especially when the other political party is in power. All this, and yet no serious efforts are undertaken to actually do anything about the problem.

It's not hard to understand why. The policy decisions required to contain debt (raising taxes or cutting spending or both) are essentially political suicide at this point. People have a sense of entitlement now that says no one will ever have to make any sacrifices. Central banks stepping in to create all the money needed to prevent widespread economic contraction after the last crisis has simply re enforced that sense of entitlement.

None of this is ground breaking news. Most people kind of know instinctively that the above is basically true and just don't think about it much since the system still rocks along and their daily lives are not disrupted.

This situation creates a couple of key questions in my mind:1) Given the above situation - how has the US (and by extension the world) been able to avoid a systemic crisis resulting from the overhang of outstanding sovereign debt?2) How long can the US (and by extension the world) avoid a debt related systemic crisis?a) less than two more years?b) two to ten years?c) more than ten years?d) a new international system (a reset if you will) will emerge on its own before we get a major systemic crisis (debt related or otherwise)e) none of the above or a different answer

These are the key questions to consider in my view. If no new major systemic crisis is coming for years and years, not much is likely to change very quickly. If a new major systemic crisis arrives in the not too distant future, all kinds of potential for highly disruptive change (good and bad) will exist. The latter impacts everyone in their daily lives, the former probably goes mostly unnoticed.I decided to put these two questions to some experts to see what their thoughts are on it. Below are the unedited comments they sent me.
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From a reader who works in this arena who prefers to be unattributed:

To respond to your question (#1) ...

"Over the past decade, many boundaries of sound monetary management have been crossed, with favourable marketing (of the lipstick-on-a-pig variety) working its charm to drown out the protests of those who would have respected the rules.

Many monetary system-level changes since 2007 have been clever 'back room' sophisticated survival methods that are typically rather difficult to describe. An interesting paper by Philip Bougen and Joni Young called "Fair value accounting: Simulacra and simulation" explains: "Values are being assigned to financial instruments which do not reflect some external accounting reality that is ‘out there’ merely awaiting discovery. Rather this reality is being imagined and might be reimagined in a multiplicity of ways at the intersection of different calculations and different assumptions. ... ... it is precisely because of their application in an accounting context categorized as fair value accounting, one with a market focus, yet one with an absent market reality, that the use of simulacra need to be highlighted. Reference to an absent market as an authoritative basis for simulation, invests the market (albeit absent) and the associated simulacra with a reality they do not possess. Indeed, many of these instruments have never actually been traded on an organized secondary exchange. ... ... the construction of a reality of various clearly delineated levels of inputs and a stylized market focus for valuation purposes evaporated as quickly as it was formulated, as ‘anomalous’ circumstances and considerations intervened, requiring connections between the various levels of inputs. Given the brokered transaction basis of OTC derivatives we suggest that the anomalies associated with ‘market prices’ might in the future prove more common than previously considered." (pg 399)

Presenting this method in a formal respectable article from the ECB (etc) makes it seem entirely coherent. Well, it is. But one can also readily imagine a Monty Python skit called "Currency Swap Line" which would equally reveal it for what it is: a system-level hack. Perhaps one should rewrite the words of "I'm my own grandpa" into a song about this method of monetary system management. For some detail on how things have come about, see this paper from the Federal Reserve Bank of Cleveland -- and the references therein. Some choice phrases are...

"Increasingly controversial, the Exchange Stabilization Fund is used to influence the international value of the U.S. dollar.

"This impedes an informed public discussion of ESF operations.

"...explicitly authorized it to operate without congressional oversight and accountability.

"...the Fed warehousing arrangement allows the ESF to take a leveraged position in foreign assets that is not reflected on the ESF’s balance sheet.

Swaps are not new, nor are they 'bad'. Back in 1990 the World Bank funded development of methods for the valuation of "Debt-for-Nature Swaps". That was a clever (fully transparent and within-rules) bankruptcy-management arrangement for massively indebted governments, led by some bright people at the World Wildlife Fund and the Natural Resources Defence Council. They thought up a way to adapt the currency swap method. Bad debt title in USD was sold to environmental organizations at hugely discounted rates, and payment of the remainder was carried out in local currencies to fund large-scale ecological protection through counterpart organizations in those countries."

In response to Question #2A little like (d) but rephrased as (e): a new international system is continually emerging by fits and starts through a combination of hasty patch-ups and thoughtful novel designs, as we lurch along from crisis to crisis, with a bright idea here and a bright idea there. Economies as a whole (like ecosystems as a whole) don't really die; they just rot. See Joseph Schumpter's work on creative destruction.

"My comments on your two questions are that I don’t think the U.S. will ever be driven to default on its debt for three reasons. First, our financial markets are so deep and broad that they will take a lot of stress. Think of Japan with a much higher debt burden than we now have. Second, we have no foreign currency debt as we are able to borrow in our own currency. Third, we almost always wake up and fix problems before they destroy us. On the other hand we have also gotten used to big deficits and don’t take them as seriously as we should so we might stay asleep too long. If we reach the tipping point, the rapid evaporation of confidence would be almost impossible to stop or reverse.If the U.S. federal government ever defaults (not likely as I argued earlier), it will most likely take the form of inflation. While inflation is a tax, unlike other taxes it reduces the real value of existing debt public and private. Other forms of default and the resulting financial restructuring would reduce the real value of specific, targeted debt such as federal bonds etc."

"I just keep on thinking of what Adam Smith said when somebody came to tell him that the American colonists had defeated the British army and that this would be the ruin of our nation: “Young man,” said Adam Smith, “there is a great deal of ruin in a nation.” The US of A ain’t ruined yet. "

"You never can tell what types of events might conspire to become the change, or when these might occur. System-level transformation can go unrecognized even by attentive participants within, until it's effectively the norm. The following is from a paper I did a quarter century ago on investment appraisal criteria (extending a list by systems design engineer Dr. James Kay, U Waterloo):

"Complex systems are:

Unique - Each evolves through distinctive physical and historical circumstances;

Discontinuous - Catastrophes and irreversible bifurcations can be internally generated;

Not Predictable - Pivotal phenomena may not always be statistically significant;

Pluralistic - At any moment several succesional configurations coexist;

Fickle - From any state there are innumerable alternative developmental pathways; and,

Self-Organizing - An open system enduring a persistent but moderate disturbance can, under some conditions, respond by establishing new stable structures to accommodate it."

From Dr. Leanne Ussher (Affiliate Scholar - Institute for Advanced Sustainability Studies)"I actually don't agree with your premise.I believe it is extremely important that there to be a clear distinction between US Federal government debt, and private debt (especially emerging market debt, which could be both private and sovereign). The fact that the federal government is NOT going to default on its debt (banning a political hijacking from the tea party) means that its debt excesses do not have the same impact as private debt. (Even US state debt and government sponsored enterprise debt could be easily taken over by the Federal Government in an emergency – e.g. the bailout of Fannie Mae). US Federal debt is quite different than private debt, since ultimately they can monetize their debt.Federal government debt if used correctly can even save a financial crisis from escalating. It is true that this may cause moral hazard, or inflation, but this is something quite different from what you are inferring in your blog: excess US sovereign debt and a portending financial crises.Conflating private debt with Federal Debt is a common mistake – and I believe it is common due primarily to ideological reasons. The famous ‘debt clock’ that you cite, only concerns itself with government debt, and was switched off when the national debt was decreasing in the Clinton years. Highlighting its ideological motivations. The rising debt I’m concerned about is the rise in emerging market corporate debt, emerging market US dollar carry trades being reversed, and potentially private student debt, corporate debt, and financial corporation procyclical capital requirements.The US is still currently the issuer of the world's reserve currency. What was of concern in the 2008/09 crisis was US private debt of financial firms, household mortgage owners, and a few non-financial firms. Too big to fail among private financial institutions (which to bail out -- not GSEs which were always going to be bailed out), and contagion across the national and international financial community.The Federal Reserve was and will be rescuing private markets in the next crises (or overseas governments and their central banks extending USD swap lines). The Fed was not rescuing federal US debt markets, which is where everyone was running to, and they will run there again. Not until there is an alternative will the US suffer from its exhorbitant debt privilege, and even then it will be a slow burn (like Japan).The US Federal government (like any federal government that issues debt in its own currency) can readily monetize and deflate its debt. This may cause inflation, and I’m not arguing for inflation. But inflation is a tax like any other. It is often levied on the poorest in a society, those holding assets or wages that are not indexed to inflation, and not debtors. But it is across the board.I think, if you really want to blame Federal Debt for our next financial crisis, you would need to build a much more systemically related story of twin deficits, but even then I don't think I would be there.US Federal debt and inflation is not going to be the next financial crisis. Rather, the debt deleveraging spiral that brings down private entities and their counter parties, across international borders, especially in the emerging markets, and here at home, will be a problem, but they will be running into US Treasuries when the crash occurs, not out of it."

Added note: Recently, former Bear Stearns Director Nomi Prins wrote this article in which she attributes what she calls "dark money" from the Fed and other central banks as helping to prop up the system and avert collapse. Here is the concluding statement from her article:

"Dark money rules the world, and it could keep the bull market running longer than most people expect, even though the eventual turnaround could be ugly."It appears that our panel of experts mostly agree that central banks can and do use the tools available to them to keep the system afloat and can do this much longer than many people would expect. The first comment in the list above provides some specific examples of some of the tools available. Dr. Ussher makes a distinction between privately held debt and sovereign debt and feels the former is where the most risk lies in the financial system. If the consensus of the views above is correct, it seems that what we should watch for is if the transition from the system we have today into whatever evolves in the future can be managed in an incremental way to avoid the sudden collapse so many watch for and expect at some point in the future (whether from sovereign debt or from private sector debt). Of course, only time will provide the answer as to what actually happens.

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